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sustaining prices, than money without, or with less, confidence. And
throughout the business cycle the amount of confidence, expressed in
such ways as the readiness to grant credits and in the easy extension
of the time of collection, is constantly changing. Over-confidence at
one time is suddenly followed by widespread lack of confidence. This
has led some to say that lack of confidence is the cause of crises.
This is a truism, but it does not explain what is the real cause of
this lack of confidence, which, when the crisis comes, is not mere
unreasoning fear that needs only to ignore the danger to banish it.
Might it not just as truly, if not more truly, be said that the cause
is _over-confidence_ in the period preceding the crisis?

The essential characteristic of a crisis is the forcible and sudden
movement of readjustment in the mistaken capitalization of productive
agents. Capitalization runs through all industry. The value of
everything that lasts for more than a moment is built in part upon
incomes that are not actual, but expectative, whose amount, therefore,
is a matter of guesswork, or "speculation."[10] Many unknown factors
enter into the estimate of future incomes. The universal tendency
to rhythm in motion (material or psychic) manifests itself in an
overestimate or underestimate of incomes and of every other factor in
value. This is emphasized by a psychological factor called sometimes
the "hypnotism of the crowd," and sometimes, the "mob mind." Most
men follow a leader in investment as in other things. The spirit of
speculation grows till often it becomes almost a frenzy, and people
rush toward this or that investment, throwing capitalization in some
industries far out of equilibrium with that in others.

The cause of crises immediately back of the maladjusted capitalization
thus is seen to be a psychological factor; it is the rhythmic
miscalculation of incomes and of capital value, occurring to some
degree throughout industry, but particularly in certain lines. This
subjective cause in men is given an opportunity for action only when
certain favoring objective conditions are present.

§ 11. #The use of credit.# Most noteworthy of these objective
conditions is the general use of credit. The credit system greatly
enhances the rhythm of price. If the value of a thing that is fully
paid for falls, the owner alone loses; but if the value of a thing
only partly paid for falls so much that the owner is forced to default
in his payment, the loss may be transmitted along the line of credit
to every one in a long series of transactions. A credit system, highly
developed, is a house of cards at a time of financial stress. Demand
liabilities are at such a time the greatest danger, so that the banks,
ordinarily the pillars of financial strength, become at such a time
the points of greatest weakness in the financial situation. If many
of the customers were not restrained by their sense of personal
obligation to the banks, by the strong pressure which the banks can
bring to bear upon them, or by the force of public opinion among
business men, from withdrawing the balances to their credit in a time
of crisis, all commercial banks would become insolvent at once in a
crisis by the very nature of their business; for all their ordinary
deposits are nominally payable on demand.

§ 12. #Interest rates in a crisis.# In normal times there is always
outstanding a great mass of short-time, commercial loans.[11] The
motive of the borrower, in most cases has been to hire more labor and
to buy more materials for use in his business. Ordinarily these loans
can and are renewed without difficulty or are replaced by others,
based on the security of new business transactions in unbroken
succession. Now at the time of a crisis a general contraction of
credit occurs, and all borrowers with maturing obligations are faced
with bankruptcy. The effort of the business man at such a time is not
to make a positive profit, but to save what he can from the threatened
wreck. The demand for short-time loans, therefore, in such times
of stress, fluctuates rapidly, and exceedingly high interest rates
prevail in these loan markets for a few days or a few weeks, rates
which have only a remote relationship with the usual capitalization of
most agents.

The distress of the business man is magnified by the fact that it
is just at such times that both the equipment he has bought and the
products he has made become temporarily almost unsaleable at prices as
high as he paid for them when he bought them with the borrowed money.
He may know that prices will soon be higher, but he cannot wait.
Various courses are open to him in this emergency; he may borrow the
money at a very high rate of interest, holding the goods for better
prices; or he may sell the goods under the unfavorable conditions; or
he may sell other capital such as stocks and bonds. The end sought
is the same - to get ready money; and the methods are not essentially
unlike - the exchange of greater future values for smaller present
values. The sacrifice sale thus reveals the merchant's high estimate
of present goods in the form of money. The purchaser of some kinds
of property in times of depression is securing them at a lower
capitalization than they will later have. The rise in value may be
foreseen as well by seller as by buyer, but the low capitalization
reflects the high interest rate temporarily obtaining. A.T. Stewart,
once the most famous New York merchant, is said to have laid the
foundation of his fortune when, being out of debt himself, he bought
up the bankrupt stocks of his competitors in a great financial panic.
The high interest at such times is but the reflection of the high
premium on present purchasing power.

The worst of the evils of crises are confined to the markets where the
greatest numbers of short-time loans are made. Most of the long-time
loans do not fall due in such seasons of stress, and the great mass of
slowly exchanging wealth alters little and slowly in price. Such loans
as fall due can generally be renewed for long periods at rates little
higher than usual, the market for long-time and short-time loans being
in large measure independent of each other. But they are not quite
independent, and some lenders take whatever sums they can collect on
maturing long-time obligations and loan them on short terms at high
rates of interest, or buy goods, whole enterprises, bonds, and stocks,
at the unusually low prices temporarily prevailing. The effect of this
is to raise somewhat the interest rate on long-time paper to accord
with the new conditions.

§ 13. #Dynamic conditions and price readjustments.# Another condition
favorable to the rhythmic movement of capitalization is a dynamic
economic society. The past century has opened up new fields for
investment on an unexampled scale. Investment has advanced both
intensively and extensively in a series of great waves. New machinery
and processes have given undreamt of opportunities for enterprise in
the older countries, and the physical frontier of investment has moved
outward with the march of millions of immigrants to people the fertile
wilderness. Such factors disturb the equilibrium of prices both in
time and space, give a powerful impulse toward higher values in
the older lands, and stimulate the hopes of all investors. When the
balance between the capitalizations of various industries and between
the incomes of the various periods proves to be false, the inevitable
readjustment causes suffering and loss to many, but particularly in
the inflated industries. But, because of the mutual relations of men
in business, few even of those who have kept freest from speculation
can quite escape the evils.

Among the dynamic conditions in industry are changes in the general
price level whether due to changes in the production of the standard
money commodity (relative to population) or to changing methods of
doing business. If the price level is falling (i.e., the standard unit
is appreciating), the burden of the great mass of outstanding debts
is growing heavier upon the debtors.[12] Sooner or later some of them
break down under its weight. At such times many attempt to shift their
capital from active investments such as stocks, to passive investments
such as bonds. When the price level is rising, the opposite conditions
prevail. But such adjustments proceed uncertainly and unevenly in
different industries, with much speculation in shifting from one type
of business to another, and with much accompanying miscalculation.

§ 14. #Tariff changes and business uncertainty.# Another variable
influence in American business has been the tariff. Every tariff
revision, whether the rates go upward or downward, shifts somewhat
the relative opportunities and profitableness of different industries.
Some of these call for far-reaching readjustments of investments and
of productive forces. Some persons gain and some lose by every such
change. It is observed that a reduction of tariff rates seems to have
a more disturbing effect upon business than does an increase. This
probably is because the industries favored by protective tariffs in
America are those most fully within the circle affected by crises;
whereas most of the consumers adversely affected by a rise of tariff
rates are outside the commercial circles where short-time credit
is common and where the rapid readjustment of investment leads to a
financial crisis. It never has been convincingly shown, however,
that there is any large measure of correspondence in time (not to say
causal relation) between tariff revisions and crises.[13]

§ 15. #Rhythmic changes in weather and in crops#. A psychological
movement, once started, accumulates force and momentum up to a certain
point where a reaction begins. This rhythmic movement as it appears
in the capitalization of enterprises is favored and magnified, we
have seen, by the wide use of credit and by the constantly changing
technical and physical conditions of industry. These call for constant
revaluations of the sources of incomes, thus destroying customary
and habitual valuations. But why should the cycle begin or end at one
point of time rather than at another; and what determines the length
of the cycle? Some of the new dynamic forces such as inventions and
growth of population are distributed pretty regularly along the line,
so that their influences are nearly equalized. But occasionally
some large impulse may serve to start a swing and if this impulse
is somewhat regularly repeated, it may serve to keep up the rhythmic
motion. True, the lack of coincidence in the impact of various
influences which occur accidentally, such as political changes, wars,
and the rapid opening of new routes of transportation, would serve
to hasten or to retard, perhaps for a time quite to alter, what would
otherwise be the rhythm of the cycle. That there is nevertheless, a
noticeable degree of regularity in the recurrence of crises may be due
to the presence of one dominating factor.

Alternation of good and poor harvests has always seemed to be
favorable to business prosperity. In America since about 1865, farm
products have constituted the larger part of our exports, so that a
succession of large harvests has usually acted to stimulate exports
(one of the features of a period of prosperity), to give us a larger
credit balance in international trade, and to reduce the rate of
exchange. Large harvests of the staple agricultural crops in America
have been known to be closely related to the amount of rainfall in the
three most important growing months. Recently, it has been shown that
the rainfall of the Ohio Valley occurs in cycles of about eight years,
and in a larger cycle of thirty-three years. The cycle of yield per
acre of the nine principal crops is shown to correspond closely with
the cycle of pig iron production (one of the best single indices of
growing business) dated one to two years later.[14] As the cycles of
rainfall and of harvests are not coincident in different countries, it
will require further study to adjust to these observations the fact
of the world-wide extent of the great financial crises. But a better
understanding of objective conditions of this kind will give fuller
meaning to the psychological interpretation of crises.

§ 16. #Remedies for crises#. The financial crisis must be looked upon
as an economic disease which brings many evils in its train. The need
is not merely to mitigate the severity of the brief period of crisis,
but also to smooth out the curve of the business cycle so as to reduce
periodic unemployment, the lottery element in profits, and the number
of unmerited failures in business. Several measures may aid toward
this end. In the past the crisis has been more severe in America than
in Europe because of certain well-recognized defects which now have
been largely remedied in the Federal Reserve Act.[15] The provisions
whereby any one may get credit on good commercial assets should
make it impossible for a crisis to degenerate into a panic. This
legislation has provided springs to reduce the jolt of the change from
a higher to a lower level of prices.

Probably other improvements may be made in our banking laws. Competent
students of the subject have urged that the payment of interest
on deposits not subject to notice before withdrawal should be made
unlawful, because demand deposits constitute the greatest danger at
critical times. In principle this objection is sound, tho experience
may show that this evil has been practically remedied by other
features of the Federal Reserve Act. Moreover, bankers could, by
pursuing a more conservative policy, discourage speculative methods of
enterprise. The strong public disapproval of stock-market speculation
on margins may some day be able to express itself effectively in ways
that will not injure healthy business. Greater stability in our tariff
policy would remove a constantly disturbing factor in prices, as would
likewise the stabilizing of the standard of deferred payments. In
the attempt to remedy the great evil of unemployment, public works of
every kind might be planned and distributed in time so as to better
equalize the demand for labor and materials. Finally, much better
commercial statistics are needed, and for collecting them and
reporting the outlook, government organization is required comparable
in range and methods to the weather bureau.

It cannot be expected, however, that financial crises, in the sense of
general readjustments of prices downward from time to time, ever
can be completely abolished. There will always be changes in general
industrial conditions calling for reevaluation of the existing sources
of income; and in this process there will always be a tendency to
rhythmic swing like that of a river, which carries the stream
of prices now on this side of the valley, now on that. But this
fluctuation of general prices surely can be so greatly moderated in
magnitude and in evil results as to make the word "crisis" almost a
misnomer. It is toward the attainment of this irreducible minimum of
uncertainty and disaster in business that efforts should be directed.

[Footnote 1: On the way these affect private profits see Vol. I, pp.
340, 341 (and references there given in note), 348 ff. and 361 ff.
There are thus good reasons for discussing crises in connection with
profits, as well as with money and banking.]

[Footnote 2: See Vol. I, pp. 51, 154, 300-302.]

[Footnote 3: See below, ch. 15, sec. 5, on the tariff legislation at
this time.]

[Footnote 4: See ch. 8, sec. 1.]

[Footnote 5: See ch. 6, sec 5.]

[Footnote 6: See diagram of business failures 1890-1914, in Vol. I p.

[Footnote 7: In the first annual report of the United States
Commissioner of Labor is given a long catalog of theories that have
been suggested, many of them quite fantastic.]

[Footnote 8: See Vol. I, ch. 38, on Abstinence and Production.
Believers in the glut theory usually condemn efforts to encourage
frugality among the masses, calling it the "fallacy of saving."]

[Footnote 9: See Vol. I, ch. 37, secs, 6 and 9.]

[Footnote 10: See e.g., Vol. I, pp. 271. 335, 365 367.]

[Footnote 11: See Vol. I, p. 304.]

[Footnote 12: See above, ch. 6, on the standard of deferred payments.]

[Footnote 13: See note on tariff legislation and business crises, end
of ch. 15.]

[Footnote 14: In both cases there is what is called in statistics
a high degree of correlation (viz., .719 and .800), indicating that
there is that percentage of probability that there is some causal
relation between the two sets of figures.]

[Footnote 15: See above, ch. 9, secs. 5, 6, 8.]



§ 1. The nature of saving. § 2. Economic limit of saving. § 3. Commercial
bank deposits of an investment nature. § 4. Investment banking.
§ 5. Savings banks in the United States. § 6. Typical mutual
savings banks. § 7. Postal savings plan. § 8. Advantages of the postal
savings plan. § 9. Collection of savings and education in thrift. § 10.
Building and loan associations. § 11. The main features. § 12. The
continuous plan. § 13. The distribution of earnings. § 14. Possible
developments of savings institutions.

§ 1. #The nature of saving.# The motives actuating the different
classes of lenders may, for our present purpose, be reduced to two:
to postpone the consumption of income, and to obtain a net income
from wealth (or investment). Saving always is relative to a particular
period and is for more or less distant ends. The child saves its
pennies to go to the circus next week, the working girl saves her
dimes for a new hat next spring, the earnest high school pupil saves
to go to college next year, and the provident man saves for his
family's future needs and for his own old age. But always, to
constitute saving, there must be for the time a net result: the
excess of income over consumptive outgo in that period. This is easily
distinguishable from various forms of pseudo-saving of which many
persons that are really spending all their incomes are very proud.
Such forms are: planning to buy a particular thing and then deciding
not to do so, but buying something else; finding the price less than
was expected, and thereupon using this so-called saving for another
purpose; spending less than some one else for a particular purpose,
such as food, but off-setting this by larger outlay for another
purpose, such as clothing; spending all one's own income but less
than some one else with a larger income. We may define saving as the
conversion, into expenditure for consumptive use, of less than one's
net income within a given income period.

Saving goes on in a natural economy both by accumulation of indirect
agents and by elaboration so as to improve their quality.[1] It goes
on to-day by the replacement of perishable by durative agents, as in
replacing a wooden house by one of stone or concrete, and by producing
wealth without consuming it, as in increasing the number of cattle on
one's farm. But saving has come to be increasingly made in the form
of money (or of monetary funds), and in this chapter we shall consider
some of the ways in which this can now be done.

§ 2. #Economic limit of saving#. There is an economic limit to saving,
as judged from the standpoint of each individual.[2] The ultimate
purpose of every act of saving is the provision of future incomes,
either as total sums to be used later or as new (net) incomes to be
received at successive periods. The economic limit of saving in each
case is dependent upon the person's present needs in relation to
present income and conditions, as compared with the prospect of his
future needs in relation to his future income and conditions. Each
free economic subject must form a judgment and make his choice as
best he can and in the light of experience. There is no absolute and
infallible standard of judgment that can be applied by outsiders to
each case. Yet there is occasion to deplore the improvidence that is
fostered and that prevails, especially among those receiving their
incomes in the form of wage or salary. Considered with reference to
the possible maximum of welfare of the individuals themselves, the
apportionment of their incomes in time is frequently woful. It is
uneconomic for families of small income to save through buying
less food than is needed to keep them in health; but it is likewise
uneconomic to spend the income, when work is plentiful and wages good,
for expensive foods having little nutriment and then, for lack of
savings, to go badly underfed when work is slack and wages are small.
There is for each class of circumstances a golden mean of saving. The
saving habit may develop to irrational excess and become miserliness,
but this happens rarely compared with the many cases where men in the
period of their largest earnings spend up to the limit on a gay life
and make no provision for any of the mischances of life - business
reverses, loss of employment, accidents, temporary sickness, permanent
invalidity, or unprovided old age. Despite the development of late of
new agencies and opportunities for saving there is need of doing more
toward popular education in thrift.[3]

§ 3. #Commercial bank deposits of an investment nature.# If a
commercial bank pays no interest on demand deposits there is no motive
for the depositor to keep a balance larger than he needs as current
purchasing power. When his bank account increases beyond that point,
it becomes available for a more or less lasting investment to yield
financial income. If the sum is small or if the owner is at all
uncertain as to his plans or if he is not in a position to find
another attractive form of investment, the offer by the bank of a
small rate of interest on special time deposits (2 to 3 per cent is
not an unusual rate in such cases) will suffice to cause him to leave
such funds in the bank. Since about 1900 the practice has been greatly
extended of paying interest even on "current balances" of regular
checking accounts (demand deposits). If the new 5 per cent rule[4] as
to reserves against time deposits operates to cause commercial banks
generally to pay a rate ranging from 2-1/2 to 3-1/2 per cent on time
deposits, their amount will doubtless increase greatly. But still, in
the future as in the past, those depositors having funds that can be
invested for considerable periods will seek a higher rate of interest
than can be obtained from commercial banks.

In their loaning function the "commercial" banks (as the adjective
indicates) serve mainly the special needs of the _commercial_ elements
of the community - business men borrowing for short terms to carry out
particular transactions. Loans made on short-time commercial paper
(quick assets) are very suitable to the needs of a bank that has its
liabilities largely in the form of demand deposits. Time deposits can
be more safely loaned on the security of real estate and for longer

Despite their limitations in this respect, the commercial banks must
be recognized as of growing importance in the work of encouraging and
collecting small savings, which in many cases are better invested in
other ways. In 1916, the centenary of the beginning of savings banks
in this country, a nation-wide propaganda was undertaken by the
American Bankers' Association for the encouragement of savings.

§ 4. #Investment banking#. Enormous amounts of securities issued by
governments or by corporations (railroad or industrial) are now on
the market and to be bought conveniently by private investors. Through
special bond houses some bonds are to be had in denominations as small
as $100 and $500. The regular brokers on the stock exchanges buy and
sell, for a small commission, the regular bonds and investment stocks.
Several large statistical and financial expert agencies[5] in return
for an annual subscription, offer advice to investors regarding
general market conditions and special securities.

For a large number of investors the personal examination and selection
of sound securities is too difficult a task. To serve their needs many
bonds and trust companies have of late developed special departments
for investment banking. Through these agencies the banks are
constantly placing as relatively permanent investments securities
which they have bought or have aided "to float" or which they handle
only as commission agents. In any case the real investment banker
is bringing to his task special training and a high sense of

Online LibraryFrank Albert FetterModern Economic Problems Economics Volume II → online text (page 12 of 40)